Exports and fiscal stimulus support growth momentum

Exports and fiscal stimulus support growth

Growth is expected to edge down slightly but remain robust in 2019, thanks to exports and budgetary support. The contribution of exports could nevertheless be slightly lower than in 2018, as the US-China trade war will weigh on Chinese demand for South Korean products. South Korea’s largest export by value – semiconductors – may be particularly impacted in the short run. This could affect the secondary sector and South Korean industrial conglomerates (chaebols). Deteriorating confidence indicators could slow private investment. Rising labour costs also pose a threat, particularly if not accompanied by productivity gains and corporate tax reductions. This is especially true for the ICT sector. Moreover, stricter regulation on mortgages should continue to weigh on investment in construction and real estate. Nonetheless, a more expansionary fiscal policy should offset the decline in private investment and promote growth. An increase in public employment, the minimum wage, and social spending is expected to support consumption. However, it is expected that the latter will be constrained by high household debt levels (155% of disposable income) as well as a sluggish labour market, with low female participation rates and relatively high youth unemployment (around 10%). Inflation is expected to stabilise around the central bank target (2%) in 2019, after increasing due to higher oil prices. The latter justified two interest rates of 25 basis points each since the start of the tightening cycle on November 2017. However, the monetary policy setting is expected to remain accommodative through the first half of 2019 as inflation pressures abate, to avoid throttling the consumption of highly indebted households.

Slight decrease in the current account surplus not a concern

The budget surplus is expected to shrink as a result of the government’s expansionary fiscal policy. Government payrolls will continue to increase, while the minimum wage is expected to be revised up by 6% to KRW 8,350 for 2019. Various subsidies to consumers and financial support to SMEs will also weigh on public spending. The defence budget will be increased by 8.8% in 2019 to support South Korea’s military reform programme. The growth of spending in social welfare and defence will be partially offset by a decline in infrastructure spending. Corporate taxes remain amongst the highest in the OECD (at around 30%), which will contribute to higher tax revenues. Public debt, which is lower than the OECD average, is expected to remain stable and low risk. Household debt continued to rise in 2018 and remains a source of concern.

In 2019, the current account surplus is expected to decline but remain positive. The balance of goods is likely to remain in surplus, although export growth should be slightly lower than that of imports due to mounting trade war risks. The steadying of relations with China is expected to continue to significantly boost tourist numbers, which plummeted in 2017. Foreign exchange (FX) reserves will remain at a comfortable level, and the rise in the central bank's key interest rate has helped mitigate the risk of FX depreciation. Policymakers should not be too concerned about FX depreciation and policy divergence with the US FED as the South Korean economy does not have a financing gap; a weaker won is actually positive for its export sector.

Improving ties with North Korea, but risks remain

Following the March 2017 dismissal of Park Geun-hye on corruption allegations, Moon Jae-in (Democratic Party) was elected President with an economic programme to stimulate growth, initiate social reform, and reduce the influence of the chaebols. After nearly 10 years of a Conservative presidency, and despite the circumstances of the election, the transition was smooth. However, with only 40% of seats in the National Assembly, the President will continue to encounter some difficulties passing laws.

President Moon’s popularity has been largely bolstered by a move to engage in strategic dialogue with Pyongyang. President Moon and North Korean Leader Kim Jong-un agreed to complete denuclearisation of the Korean Peninsula during the April 2018 inter-Korean Summit. This was followed by a bilateral meeting between US President Donald Trump and Kim Jong-un in Singapore on July 2018. However, North Korea has threatened to restart its nuclear programme if an agreement with the United States is not made. South Korea postponed the permanent deployment of the Terminal High Altitude Area Defence (THAAD) system on environmental concerns. The move reflects the difficulties that the new regime will experience as it walks the fine line of balancing its relations with both the United States and China.